HIPO - Hippo Holdings: A Differentiated Approach That Doesn't Showcase Profitability

2023-08-18 09:46:47 ET

Summary

• Hippo Holdings Inc. is using AI and advanced technology to provide customized home insurance coverage.
• The company's gross loss ratio is at 107%, resulting in significant losses and the need to issue new shares.
• While HIPO has shown growth in certain segments, the lack of profitability and high risk make it a sell.

Introduction

A small beat on the top line didn't suffice when the bottom line was missed by quite a lot in the latest earnings report from Hippo Holdings Inc. (HIPO). The company is taking a different approach to the home insurance industry by combining a variety of popular techniques right now, especially AI to create what some would consider customized coverage for homeowners. This approach is yet to showcase the full capabilities yet though as the bottom line remains negative and the last report showcases a miss of nearly $2 per share for the company. This is quite honestly pretty bad and I think a correction in the share price seemed obvious.

As for HIPO, the gross loss ratio is at 107% which quite honestly is pretty horrific. This has trickled down to the company losing a lot of capital and issuing new shares has been common practice by them. I think the technology that HIPO has is exciting but if it can't generate positive net incomes then you aren't investing in anything fundamentally sound in my opinion. I find the risk to heavily outweigh the rewards here and will be rating it a sell.

Company Structure

As was quickly mentioned in the beginning part, HIPO is engaged in the home insurance industry where it provides home protection insurance in both the US and the District of Colombia. The insurance products that the company has includes insurance against risks of fire, wind, and theft among other personal and commercial insurance products too.

The company has an advanced technology platform which it distributes its insurance from and this has become the hallmark of the company and its niche approach to the market.

Policies are offered online and over the phone which creates a more seamless experience for the customers and ultimately has been a driver of growth for the company, but the challenges still persist in reaching profitability.

Some of the highlights recently from the company have been the improvement of the loss ratio. This is a key point in measuring the company's ability to generate solid earnings for shareholders. The core gross loss ratio is improving by 12 pp YoY to a level of 63%. The overall gross loss ratio still sits above 100% and without any significant improvement in the last quarter the share price tumbled following the news. It decreased by nearly 50% in the span of a few days and risks still seem to be very present for investors in my opinion. I think the biggest hinge right now with HIPO is the lacking margins. Customer growth is one thing, but having that trickle down to better net margins is another thing. So far we don't seem to be seeing any significant improvements on this front in my opinion.

Earnings Transcript

From the last earnings call by the company, there are some good comments made by CEO Richard McCathron that I think are worth highlighting here. It primarily touches on some of the segments in the company and the improvements made to them.

"In our Services segment, we are ahead of plan on TGP and revenue, while remaining within our fixed cost budget. At a time when insurer appointments are tough to come by, our First Connect platform is using its technology to facilitate business between agents and carriers. Its Carrier Store, which launched in October, already supports over 80 carriers, connecting them to thousands of independent agents. In Q2 '23, we facilitated 14,800 agency appointments, up over 30% from Q1 2023, and up over 400% from the prior year quarter".

Seeing growth coming out ahead of expectations is great to see, but coming quarters will still need to be focused on the loss ratio decreasing to incentives and keep investors interested still. That is where my focus lies at least, I believe strong growth is almost worthless if it can't be translated into bottom-line earnings.

"The long history of insurance is one of innovation and change. Some opportunities arrive suddenly after major loss events like Hurricane Andrew. Some came after legislative actions like the passage of Prop 103 in California. Some came when the innovative spirits of great companies led change in the distribution and pricing of products like auto insurance. We believe the U.S. homeowners market is in the early days of a challenging period. But we see the opportunity for a tech-enabled company like Hippo to be the solution for many U.S. homeowners".

Even if HIPO sees a great market opportunity right now I think the lacking margins makes it a sell. Besides that, worrisome factors like hurricanes and other natural disasters are likely to bite hard on the earnings of the business. Without a strong history and resilience built up yet, a sudden catastrophe could set the company ablaze almost and margins would sink even lower. That could trigger a significant share dilution and share price sell-off too, in my opinion.

Valuation

Based on sales, HIPO isn't trading that high actually, the p/s is just 1.19 on an FWD basis. This discount seems to come from the smaller size the company has, but shouldn't be confused with it offering a good deal. Below are some of the risks that I relate to the company that results in the sell. Looking at peers as well we have Fanhua Inc (FANH) for example, a company that has managed to achieve a positive net margin as opposed to HIPO. Based on the book value, FANH is trading higher and I think this premium is given because of the relative stability in the margins and the fact that with a positive bottom line, there is a higher probability for earnings to be able to be passed on to shareholders through buybacks and dividends. For FANH they have been buying back shares historically, which concludes with them receiving a higher p/b than HIPO because of the investor benefits included.

Based on book value, HIPO further exudes what I would consider a discount. With a p/b of just 0.55, it has a 46% discount rate to the sector's averages. I don't think we would be approaching a level where HIPO might be a hold until this number goes down to 0.3 instead. At that point, I think the company would be trading too low for a sell to make sense. With a negative 61% ROE as well, it showcases that HIPO isn't able to make the most of the balance sheet and leverage that into stronger earnings, which should constitute the lower multiple in my opinion. Regarding the discounts the company is receiving, I think that because of the poor margins, it makes sense for them to be within this level. Net margins for FANH which has a similar market cap are at 6.79% and the ROE is nearly the same as the sector at 10.91%. That's a significant difference as to where HIPO is at. If we see margin expansion beating out estimates then I think the share price would quite quickly bounce up. But right now that's not a bet I am willing to make.

Risk Associated

With its strong emphasis on AI and data utilization, HIPO emerges as a prospective game-changer within the home insurance sector. The potential disruptive impact it could wield is substantial, particularly if it successfully executes its strategic vision. There's an envisioned scenario where HIPO carves out a considerable niche for itself, capturing a substantial share of the homeowner insurance market. However, while the seeds of transformation have been sown, there seems to be a long time until we see any transformation into an earnings machine of a business. HIPO needs to first improve its gross profits which is likely to take some time. But as long as total generated premiums are growing at a steady rate then the company is still heading in the right direction at least. Consolidating and focusing on margin growth will come later.

The dynamics of the insurance industry underscore the need for HIPO to address multiple facets-ranging from customer acquisition to risk assessment and claim management-through its AI-driven approach. This transformational journey is not without its challenges, including the need to build consumer trust, manage regulatory complexities, and establish a competitive edge within an established market. Where it seems that HIPO is hitting the hardest is the Hippo Agency segment where the premium retention rate grew strongly to 110%, up from 98% a year prior. This is adding some support to an investment thesis at least, but fundamentals are still lacking.

Investor Takeaway

A slow transition of growth into better margins seems to be the story right now with HIPO it seems. Without proof that the differentiated approach can become something fundamentally great then the company is no more than a risky investment in my opinion. As a result, I will be rating them a sell. Perhaps one-day HIPO will become profitable, but we still seem very far out for that, unfortunately.

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